Articles Oil refining in Mexico and prospects for the Energy Reform Daniel Romo1 1National Polytechnic Institute, Mexico. E-mail address: [email protected] Abstract: This paper analyzes the conditions facing the oil refining industry in Mexico and the factors that shaped its overhaul in the context of the 2013 Energy Reform. To do so, the paper examines the main challenges that refining companies must tackle to stay in the market, evaluating the specific cases of the United States and Canada. Similarly, it offers a diagnosis of refining in Mexico, identifying its principal determinants in order to, finally, analyze its prospects, considering the role of private initiatives in the open market, as well as Petróleos Mexicanos (Pemex), as a placeholder in those areas where private enterprises do not participate. Key Words: Oil, refining, Energy Reform, global market, energy consumption, investment Date received: February 26, 2016 Date accepted: July 11, 2016 INTRODUCTION At the end of 2013, the refining market was one of stark contrasts. On the one hand, the supply of heavy products in the domestic market proved adequate, with excessive volumes of fuel oil. On the other, the gas and diesel oil demand could not be met with production by Petróleos Mexicanos (Pemex). The possibility to expand the infrastructure was jeopardized, as the new refinery project in Tula, Hidalgo was put on hold and the plan was made to retrofit the units in Tula, Salamanca, and Salina Cruz. This situation constrained Pemex's supply capacity in subsequent years and made the country reliant on imports to supply the domestic market. In this context, the choice was made to liberalize the refining industry, aiming to revive it. However, these efforts were ailed b a series of challenges, which will be the topic of analysis in this paper, and will be essential to the behavior of the industry for years to come. This paper begins with a first section to offer general considerations about the global refining industry, followed by a second section that examines its performance in the American and Canadian markets, taking into account that more of the companies that may or may not have business relationships in Mexico, they also conduct operations in their own nations. The third section introduces a diagnosis of refining in Mexico, based on industrial analysis tools throughout the entire value chain to, finally, identify the top challenges looming ahead in the new scenario of open-market competition. THE REFINING INDUSTRY AROUND THE WORLD The refining industry is strategic for the economy, as it is an opportunity to add value to oil. Its distillates are the foundation to supply countless activities in which human beings engage, including, most notably, transportation, power generation, and activities that require heat. In general, the refining industry is capital-intensive, and size and technological complexity, as well as wage costs and environmental regulations, are all relevant to its viability. The industry is composed of a set of large continuous production plants, where crude oil is separated into different fractions; for example, oil is physically and chemically processed to produce finished products, which range from very light―like liquefied petroleum gas―to the heaviest―like asphalt or petroleum coke. The refining industry also encompasses the transportation and storage of processed products, as well as delivery to consumers through distribution points. In response to market conditions, the refining industry has gone through various stages, such as surplus production capacity at the end of the 1980s and the beginning of the 1990s, or plummeting profit margins in the early years of the past decade. In general, the international refining industry continues to reinvent itself, whether by expanding capacity, renovating and/or upgrading it, in order to expand its useful life and competitiveness, with processes aimed at higher value added products, like gasoline and diesel, and limiting the production of heavy byproducts; or the use of flexible technology to process crude oil in light of problems with disposal at refineries and price volatility. The industry has also faced very narrow and volatile refining margins that have driven up operational efficiency, as well as actions to optimize the energy used, automate processes, and hire highly skilled staff, among other measures. Efforts have been made to supply the type of oil byproducts for which the market is most hungry: cleaner, more efficient, and up to required quality standards; as well as to adapt to the trend of coexisting alongside substitute fuels,2 like natural gas in the United States, adopt environmental standards into processes, which in some cases require investments that will yield little by way of returns; to process higher quality byproducts in combustion, through the incorporation of better technologies, such as is the case of gasoline with a higher enthalpy of evaporation, which makes it more efficient by cooling the fuel mix during the injection process, or simply through a mix of liquefied products obtained from renewable sources, like ethanol. Likewise, in light of the long-term returns, refining companies have sought schemes to access financing by turning to the stock market or bank loans, but also by capitalizing on their profits derived from times past when oil prices were higher, as they were between 2004 and the end of 2014. In particular, strategies have been implemented to improve the positioning of refining companies in the market. Along these lines, the international oil companies are standout examples. In addition to earning significant profits in the refining business, they have robust processing, storage, and transportation systems for petroleum-based products and even, in some cases, have upstream integration in their activities, or may focus on only on refining. The refining business operates in a free market world, even in those cases where the government intervenes. In the latter cases, some units barely manage to break even or may lose money. At close of 2014, total demand for oil byproducts hit 92 million barrels a day (mmbd), of which 49% went to countries in the Organization for Economic Cooperation and Development (OECD), which displayed a downward trend of nearly 3 mmbd since 2008 due to the effect of the economic shakeup. Fuel oil consumption suffered the most. By 2 The natural gas production boom has created jobs, especially in the transportation sector. There is also production of other liquefied fuels, such as biofuels, gas to liquid, or coal to liquid. contrast, in non-OECD nations, the demand for petroleum products has grown stronger (see Table 1). Table 1. Demand for Petroleum Products in the World 1980 and 2014 Petroleum Europe and Asia Pacific North America Rest of the World Byproducts Japan 1980 2014 1980 2014 1980 2014 1980 2014 Light 4.7 4.4 2.0 10.0 8.1 10.8 2.3 4.9 distillates Intermediate 6.7 8.7 3.2 11.0 5.1 6.8 4.2 7.4 distillates Fuel oil 6.1 1.4 3.8 2.8 2.9 0.4 2.5 3.3 Other 3.0 3.6 1.5 7.1 3.8 5.3 1.3 4.1 Total 20.5 18.1 10.5 30.9 20.0 23.3 10.2 19.8 Source: BP (2015). On the other hand, global refining capacity at the end of 2014 was higher than the demand for petroleum products, at 96.5 mmbd,3 22% above what it was in 1980, and it was non- OECD countries that saw the highest increase. The Asia-Pacific region stands out, as well as a trend in the Middle East to add value to crude, not to mention the greater installed capacity they have achieved. This stands in sharp contrast to Europe, where said capacity fell by 4.5 mmbd between 2008 and mid-2014 (IEA, 2014). Between 1980 and 2014, the refining capacity in North America declined, as did its contribution to the world total (see Table 2). As 2014 drew to a close, it was 21.3 mmbd, of which the United States accounted for 84%, Canada 9.2%, and Mexico the remaining 6.8%. The net volume of oil imported in that region amounted to a little more than 4.6 mmbd, basically due to purchases from outside the United States, which, thanks to its surpluses, made the region a net petroleum exporter. Table 2. Global Primary Distillation Capacity. Thousands of barrels per day Region/country 1980 2014 1980-2014 No. Participatio No. Participatio No. Participatio n n n 3 At year-end 2013, the total number of plants operating in the world was more than 12,000 units. United States 18 620 23.5% 17 791 18.4% -829 -4.5% Canada 2 155 2.7% 1 965 2.0% -189 -8.8% Mexico 1 207 1.5% 1 522 1.6% 315 26.1% Total North 21 982 27.8% 21 278 22.0% -704 -3.2% America Asia Pacific 12 364 15.6% 32 461 33.6% 20 097 162.5% Europe and 31 911 40.3% 23 724 24.6% -8 187 -25.7% Euro-Asia Middle East 3 528 4.5% 9 428 9.8% 5 900 167.2% Africa 2 073 2.6% 3 553 3.7% 1 480 71.4% Central and 7 251 9.2% 6 069 6.3% -1 182 -16.3% South America World total 79 109 100.0% 96 514 100.0% 17 405 22.0% Source: Created by the author with data from BP (2015). The Organization of Petroleum Exporting Countries (OPEC) estimates that 9 mmbd of primary distillation capacity will be added between 2014 and 2019, of which more than 92% will be derived from upgrades and expansions to existing plants, and the remaining 8% will be new capacity, and it is the Asian region that should show the strongest growth.